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Overconfidence and ethical contracts

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  • Lambertsen, Nikolaj Niebuhr
  • Poulsen, Morten Lund

Abstract

Introducing heterogeneous beliefs into a contracting framework allows for considering ethical behavior. Optimal contracts with heterogeneous beliefs need to balance the standard effects of risk aversion and incentives for effort with the desire for exploitation. We study the situation where the principal additionally takes an explicit ethical stance: The agent must not be worse off from accepting the contract than the agent’s outside option according to the principal’s beliefs. In this framework, heterogeneous beliefs still matter, and we fully characterize the optimal contract with an overconfident agent. The agent is strictly better off with an ethical principal. The ethical principal may be better off with an overconfident agent, leading to Pareto improvements in welfare.

Suggested Citation

  • Lambertsen, Nikolaj Niebuhr & Poulsen, Morten Lund, 2024. "Overconfidence and ethical contracts," Economics Letters, Elsevier, vol. 241(C).
    • Handle: RePEc:eee:ecolet:v:241:y:2024:i:c:s0165176524003252
    DOI: 10.1016/j.econlet.2024.111841
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    References listed on IDEAS

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    More about this item

    Keywords

    Ethics; Ethical principals; Heterogeneous beliefs; Moral hazard; Overconfidence;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General

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